GOODFUNDSADVISOR
has been in Equities for more than 27 years now.
That rich experience is shown here in his insightful articles.
However, we strongly suggest you to consult a Financial adviser.
This blog is purely for information purposes only and we do not take any responsibility whatsoever as the blog content may be changed from time to time and is generic in nature.

Sunday, June 1, 2014

GAINING FROM EQUITY VOLATILITY

Debt funds are attractive because of their stable returns
and easy liquidity. But the problem arises when you sell them within 1 year,
wherein you are taxed 30%. Moreover, we have seen that even Debt funds including the so called "safe" liquid funds could give
negative returns (June 2013)

This is where Arbitrage Funds come into picture.

WHAT IS ARBITRAGE FUND?

Arbitrage is the price difference between the Cash Market
and Derivatives Market due to Market inefficiencies.

Let us take an example :

1.ACC is quoting at Rs.980 in NSE and Rs.990 in
BSE

2.ACC is quoting at Rs.980 in NSE Cash and Rs.995
in F&O (next month)

Here, the Fund buys ACC @ 980 in NSE cash and sell in BSE @
990and the resultant difference is the
profit.

In Scenario 2, the Fund sells ACC at 995 in F&O and buys
at Rs.980 in NSE cash. So, on Expiry day (settlement date), the fund has made
risk free profit, because the Cash price and F&O tends to coincide.

This Arbitrage (price difference) could be due to multiple
factors like Dividend payout, rights issue, Buy back,etc.

Arbitrage Fund is the fund which is designed to capatilise on this
mispricing and generate returns.

ADVANTAGES

1 1.Tax treatment like Equity funds without the risk
associated with Equity.

2 2. Safer than Equity Funds

3 3. Income funds too are volatile and carry
“interest risk” too which Arbitrage funds carry no such risk

4 4. Very little chance of “negative” returns as
evidenced by the returns seen in 2008, where all kinds of Equity funds gave Negative returns, but bucking the trend, Arbitrage funds gave
positive returns.

1 1. A risk averse investor who want an exposure to
Equities and wanting to generate returns on par with Debt but save on Taxes,
Arbitrage Funds

2 2. An investor who has booked profit/recd a huge
lumpsum but does not know where to invest can consider Arbitrage Funds till he
finalises where his funds will go.

3. Uncertain markets are the ideal to lock in your
funds in Arbitrage funds.

4 4. Those who have retired or taken VRS, can keep
their corpus in Arbitrage funds (instead of Debt funds) and do a Systematic
Withdrawal Plan to not only earn Tax Efficient returns but also Debt Fund
returns.

5 5. An investor who is overexposed to Equities, but prefer
better than Liquid fund return, can go for Arbitrage funds.

Investors are also cautioned to take note that besides
Arbitrage Funds, there is a similar sounding Arbitrage Plus Fund. These
Arbitrage Plus funds carry a higher risk cause they can take even Unhedged
positions whereas a Pure Arbitrage Fund always has its position Hedged.

ALSO PLEASE NOTE :

Due to multiple trades, high brokerage charges are paid by
these funds in addition to STT, hence a High AUM would help the fund in
spreading the cost and reducing the overall Expense.

In a rising Interest rates scenario, Debt funds including
FMPs would do better than Arbitrage funds and hence it does not make sense to
invest in Arbitrage funds at those times.

Likewise, in a Rising markets, investing in a Diversified
fund would be a much better option.

So, if you are investor, who wants a Risk-free Tax efficient
fund and are unsure of the markets in present condition, you can invest in
Arbitrage Funds and do a STP into a Diversified Equity Fund.

If your investment horizon is more than 1 year but less than
3 years, you can consider Arbitrage funds, but if your investment horizon is
less than 1 year, you can look at Liquid/Debt funds.

FINALLY,

PLEASE NOTE, ARBITRAGE FUNDS ARE GOOD FOR SHORT TO SHORTISH MEDIUM
TERM, THEY ARE GOOD AT PROTECTING YOUR MONEY BUT THEY DO NOT (I REPEAT, DO NOT)
CREATE WEALTH.

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I am a Personal CFO who helps my investors plan for their LONGEST VACATION in their life......Their RETIREMENT!! All this with investments in Equities via Mutual Fund and this Blog is a small attempt to guide you too

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